We believe there is a strong link between patience and successful long-term investing, for two reasons. First, patience differentiates between long-horizon and short-horizon investors. Second, patience must be seen as a depreciating asset. Left unmanaged, it will erode and lose its value.
Our thesis comes from Patience: Not merely a virtue, but an asset – a paper I co-wrote with Geoff Warren of Australia National University and Liang Yin of the Thinking Ahead Institute – and has two main components.
First, patience has value, because it supports the ability to invest for the long term and allows the maintenance of losing positions. Second, patience running out is bad, because it can trigger a value-destructive sale (capitulation) and sends the wrong signals, which can undermine the capacity to exercise patience in the future.
Consider an investment that has a high chance of delivering a handsome return. The only problem is that we don’t know when. The return could materialise tomorrow or years down the track. What type of investor would pursue such an investment? Clearly, one with patience. They must not be too concerned with when the payoff might arrive. They must be able to stay the course if the payoff is delayed. Being able to pursue such investments opens a class of potentially rewarding opportunities that an impatient investor might overlook.
How does an organisation build and sustain patience? The query becomes somewhat more complex when there are multiple levels of two-way relationships and the need for patience to span those levels. Nevertheless, we suggest that a simple, generalised model with four elements can be used to explore solutions:
- Two levels, such as principal/agent, or governor/executive, but more generally a high-level party and a low-level party. Exclude the single-level case of the principal investing on their own behalf. The two-level idea applies between board and in-house executive within asset owners, between asset owners and asset managers, and between boss and employee within asset managers.
- The stock of patience resides with, and is controlled by, the high-level party.
- The low-level party operates under a mandate while patience remains in supply. The manner in which this is done influences the principal’s stock of patience.
- There may, or may not, be a shared understanding of the presence of patience, let alone agreement over the role it plays. We assert that the best relationships and investment outcomes involve mutual agreement over the need for patience.
It is important to note that patience alone does not lead to investment success. Patience is no substitute for skilled investment analysis but, assuming genuine investment skills are a given, what difference does patience make? The answer depends on how capital is allocated.
An investor has, broadly, three options for allocating capital:
- Risk-free assets: these give a 100 per cent likelihood of a very low return.
- Price-to-price investing: this is Keynes’s beauty contest game. It entails predicting the movement of the psychology of the market. The prices at which you buy and sell are what matter.
- Price-to-value convergence: here there is a high likelihood of an attractive payoff, and skill relates to accurate assessment of the value. But there is also the possibility that price and value remain divergent. The divergence might even get larger before convergence occurs.
Clearly, for the first option, patience makes no difference. The second option is a noisy, zero-sum game and so doesn’t seem a natural place for patience to make any difference. For price-to-value convergence, however, we argue that patience is everything.
If price diverges from value, the investor has three options: sell, concluding that their analysis of value was wrong; do nothing; or add to the position, as the prospective return has increased. It is patience, an intangible asset, that allows an investor to pursue option the second or third option.
We believe the benefits patience brings are an expanded opportunity set, protection against value-destructive short-horizon behaviours such as selling low, and reduced transaction costs as a consequence of lower portfolio turnover.
We assert that, in all but trivial cases, patience will be tested. This is why it should be viewed as a depreciating asset. Hence, it is important to understand what causes patience to wear thin, and what can be done to build and maintain it. We recommend organisations build the stock of patience from the start. This can be achieved through: gaining organisation-wide buy-in; creating an investment process based on long horizons; hiring the right people; and building a long-horizon culture. The stock of patience then needs to be maintained by: working on retaining trust; offering the right incentives; framing performance in the context of long-term objectives; and having leadership from the top.
We do not argue that long-horizon investing is easy. Nor do we claim it is the only way to generate strong investment performance or that it is appropriate for all. Nevertheless, it can be well worth the effort for organisations that manage on behalf of savers with long-horizon goals, and that are capable of positioning themselves to do so. For such organisations, we believe it is helpful to view the building and maintenance of a stock of patience as essential.